The Bond Fund Crash: What I Learned When “Safe” Investments Tanked
An article yesterday by David Lancaster detailing his bond fund investments going pear-shaped during the 2022/23 bond market crash got me thinking about what I have actually learned from this costly experience that took many of us by surprise.
Like David, I perceived bond funds as a "safe" or "stable" investment, assuming they behaved like individual bonds held to maturity. The recent downturn, however, exposed my lack of understanding. When rates rose rapidly, the market value of the bonds within the funds dropped. Since bond funds are perpetual and do not "mature" to par, investors saw the value of their fund shares decline.
My key takeaway was my lack of personal education. This, in my opinion, underscores the importance of understanding the precise mechanisms of any investment product, not just its broad asset class, to really grasp its risks and potential behavior in different market conditions. I failed with this and paid the price. Unfortunately, it was a costly lesson learned, but if nothing else, I have now had a practical demonstration of why I need to understand what I invest my money in.
My second takeaway: buying individual bonds in a bond ladder and holding to maturity is an effective strategy to navigate this risk. Holding an individual bond to maturity ensures you receive your original principal back. Daily price fluctuations become irrelevant if you do not intend to sell. Unlike my previous bond funds, which continuously rebalanced and reflected current market values, holding individual bonds isolates me from market volatility for that specific bond. I concede this will work better for short to medium term time frames and this is how I will be using them.
While buying individual bonds has definitely required more effort on my part, they offer me predictability and principal return at a defined date. That is a stark contrast to the bond funds in my portfolio during the recent downturn. My "buy and hold" approach to individual bonds has given me a path through interest rate turbulence, although inflation risk is still an issue. As a side note, there's a fantastic online tool for building UK government bond ladders. I don't think I would have managed without it.
Quite possibly over the coming years other nasty investment surprises will rear their ugly heads. My hope is I am now in a better position to insulate myself from these "unknown unknowns" by only investing in things that I clearly understand. I think this philosophy can be extended to other asset classes whether it's equities, real estate, commodities, or alternative investments. I definitely intend to double down on my education and hope for the best.
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